Financial analysis involves the use of various financial formulas (ratios) to measure the financial strengths and weaknesses of a company and to compare these strengths and weaknesses with those of other companies within an industry. Financial analysis information may be valuable to those within a company (e.g., officers, and financial managers) and to those outside of a company (e.g., investors, creditors, and security analysts).
Financial ratios are designed to show relationships between various financial statement accounts. For example, Company A may have debt of $4,000,000 and interest charges of $700,000, while Company B may have debt of $64,000,000 and interest charges of $7,700,000. The actual burden of these debts, and the companies' ability to repay them, can be determined by comparing each company's debt to its assets, and the interest each company is charged to the income available for payment of interest. Such comparisons are made by a procedure known as “ratio analysis.”
Various known categories of ratios include liquidity ratios, asset management ratios, debt management ratios, profitability ratios, and market value ratios. Liquidity ratios are designed to show the relationship of cash and other current assets to a company's current obligations. Asset management ratios are designed to measure how effectively a company is utilizing its assets. Debt management ratios are designed to measure the extent to which a company uses debt financing. Profitability ratios are designed to show the combined effects of liquidity, asset management, and debt management on operating results. Market value ratios are designed to relate the stock price of a company to the company's earnings and book value per share.
Ratio analysis may allow a financial manager to compare his or her company's financial performance with the financial performance of other companies in the same industry. In addition, trends in ratio analysis may allow a financial manager to analyze changes in a company's financial performance over time. Ratio analysis may give clues as to whether the financial situation of a company is improving or deteriorating. Financial analysis and, in particular, ratio analysis is discussed in detail in “Essentials of Managerial Finance”, Weston et al., The Dryden Press, 1987, pp. 252–259, which is incorporated herein by reference.
Performing financial analysis and interpreting results from financial analysis may be a somewhat daunting task, especially to those untrained in managerial finance. For example, to some it may not be clear how to utilize ratio analysis in assessing the financial health of a company. Moreover, it may be difficult for some to compare the financial performance of their company to the financial performance of other companies.
Financial analysis services are available from various professional advisors, such as consultants and accountants. Unfortunately, these services may be expensive. As such, professional financial analysis services may be out of reach of smaller investors and business owners.
Various financial software products and services exist that can analyze one or more of the four basic financial statements (i.e., the income statement, balance sheet, statement of retained earnings, and statement of changes in financial position). For example, Entrepreneurial Edge Online (www.edgeonline.com) is a service of the Edward Lowe Foundation (P.O. Box 8, Cassopolis, Mich. 49031) that provides on-line forms in which users can enter data. Using the user-provided financial data, various ratios and financial statements can be generated. For example, a balance sheet can be generated and ratios such as liquidity, operating and solvency ratios can also be generated.
CPAnalyst financial software, available from the Illinois CPA Society (www.icpas.org) is configured to receive financial data from users and convert this data into various types of output, including financial statements, ratios, graphs and limited narrative reports. The narrative reports, however, consist of templates having fields within which financial data, including financial ratio values are inserted. The written description in each narrative report is identical for each output report.
In addition, existing financial analysis products and services may be somewhat limited in the depth of analysis that can be produced. Moreover, existing financial analysis products and services may not be able to indicate how a company is performing relative to the competition and how the company might improve performance.